When is a yieldco actually a money-printing device? And when is it not?
Or put differently: how sensitive are yieldcos to interest rate and tax changes?
[Yieldcos are pitched to investors as dividend growth-oriented companies which distribute predictable cash-flows to investors on tax efficient terms.] Read more
Forward guidance under Ben Bernanke and then Janet Yellen has been… changeable, notes David Kelly, chief strategist for JP Morgan Asset Management, who shares a reminder of the shifting timescale.
Here’s the Federal Reserve on when it would be appropriate to raise the target range for the federal funds rate:
January 2009 — not “for some time”
March 2009 — not “for an extended period” Read more
There’s no good way to separate the duration risk premium — the compensation investors get for locking up their money for long stretches rather than constantly rolling it over — from a long-term bond yield, although plenty of people try.
A recent blog post by economists at the New York Fed gives a flavour of the challenge. You can see their results in the following chart, which attempts to decompose actual 10-year interest rates (blue) both now and in the future into pure measures of expected short-term interest rates (red) and what they call the “term premium” (yellowish): Read more
In a previous post we noted Greenspan shouldn’t have been confounded by the “conundrum” he identified in 2005, and promised a longer explanation of this claim. To refresh, here’s the full argument he made during his semiannual testimony to Congress:
Long-term interest rates have trended lower in recent months even as the Federal Reserve has raised the level of the target federal funds rate by 150 basis points. This development contrasts with most experience, which suggests that, other things being equal, increasing short-term interest rates are normally accompanied by a rise in longer-term yields.
Following up on our volatility has actually been falling post, here’s Alan Ruskin of Deutsche Bank:
The reaction in riskier assets to the recent sell-off in G10 sovereign bonds remains informative. In the relatively illiquid US high yield market, spreads have come in over the past week. Equities have seen some pick-up in volatility, but the VIX at sub 14 is very low relative bond/swaption vol. Gold vol is going nowhere. EM FX would seem to have been very vulnerable O/N and instead most the FX price action seemed to reflect moderate positioning adjustments consistent with limited s/t EM carry exposure, outside the INR. The upshot is most other markets trade with some confidence that the G10 sovereign bond sell-off will not get out of hand.
With the German 10 year bund yield closing higher in 14 of the last 16 sessions, a concentrated pocket of volatility can still be painful for those involved. The outstanding question remains whether sovereign bond market noise is technical and temporary, or the distant but distinct clanging of an alarm. Read more
The long awaited, much predicted start of the great turning point in bond markets after which yields will rise, prices fall and teeth gnash has arrived. Maybe.
We have had a moderate bit of violence and surprise in fixed income, after all. A sample of sentiment below, but a word of caution up front: higher volatility might have caused the market moves, meaning the big reaction is still to come and/or potentially distant.
Here’s Jens Nordvig of Nomura late on Tuesday: Read more
It might not be polite to say it overtly, but concerns are growing that the Fed’s rate hiking promises may be nothing more than a big bluff.
The vogue for doubting Fed rhetoric started in earnest on March 11, when Ray Dalio, founder of hedge fund firm Bridgewater Associates, wrote to investors that there was a risk if the Fed raised rates too fast it could create a market rout similar to that of 1937. Read more
Professor Krugman has a new post that tries to explain why nominal US sovereign interest rates are higher than nominal euro area bond yields. Much of the piece is useful, especially since he is right that credit risk has nothing to do with the differential between German and American borrowing costs.
Higher US rates are instead the result of differences in real rates and inflation expectations between the two countries. But we part ways with Krugman when he makes this argument in the context of expected changes in the exchange rate between euros and dollars: Read more
The Bank of England’s latest quarterly bulletin, released on Monday, contains an interesting article on “the potential impact of higher interest rates on the household sector.”
A few interesting tidbits:
–Raising rates by 2 percentage points would redistribute income “from higher-income to lower-income households”
–But would probably lead to a reduction in spending, since 60 per cent of borrowers would spend less and only 10 per cent of savers would spend more. The BoE estimates that the net effect of a 1 percentage point increase in the Bank Rate would be a reduction “aggregate spending by around 0.5 per cent via a redistribution of income from borrowers to savers.” A 2 percentage point increase would lower spending by 1 per cent. (The total impact on spending could be a bit different, however, since monetary policy works in other ways besides redistributing income from net savers to net borrowers.)
–On the whole, though, UK households are (slightly) less sensitive to increases in interest rates than they were a few years ago Read more
Could unexpectedly low levels of Treasury yields, pushed down by monetary policy in Europe and Japan, lead the Fed to raise interest rates earlier and faster than it otherwise would? That’s the prospect raised by an intriguing and important speech today by New York Fed president William Dudley. He makes dovish arguments about when rates should lift off, but forecasts they actually will rise by mid-2015, in line with consensus. He then breaks new ground by suggesting the pace of rate rises will depend on how financial markets respond to them.
(1) Dudley is dovish… Read more
If analyst comments in our inbox are anything to go by, the latest FOMC minutes, released on Wednesday, provided nothing much to write home about. Everything revealed was pretty much as expected.
One thing did prompt our eyebrows to raise, however. More on that below, but first here’s some of the reaction. Stephen Lewis at Monument Securities wrote:
The minutes of the FOMC meeting on 28-29 October sprang few surprises. Compared with earlier meetings, FOMC members gave more prominence to the risks stemming from worsening conditions elsewhere in the world but ‘many participants’ expected the impact of foreign developments on US growth to be limited.
A funny thing has happened since the Federal Reserve announced it would begin cutting back on its bond-buying on December 18, 2013: the yield curve has flattened like a pancake.
You may detect a sceptical tone there, but the question is real: does it matter if something unexpected occurs in the world of credit and rates?
We’ve been on this point for a while — assessment of risk is sticky, until it’s not — but were struck by a recent conversation with a market maker about his clients:
Everyone is acting like an LTCM.
From a tame taper to a rate rage? And on its birthday too.
As Alan Beattie says, it was a year ago this week that the “taper tantrum” shook emerging markets, after comments from Ben Bernanke raised fears of the Fed tightening monetary policy. That sucked for EMs even if the reaction to the actual taper, which began in December, was much more chilled.
But it’s what happens when rates eventually rise that’s perhaps more interesting now. From Lombard Street’s Dario Perkins (our emphasis): Read more
So, dear sceptic, you think that interest rates will go higher. Prices for debt will fall, meaning a wonderful opportunity to bet on what must occur. Easy.
Except it turns out that trading a bear market in bonds is hard. By way of example, BofA Merrill Lynch offer up the last rate tightening cycle that began on June 30, 2004. Imagine you decided to go short exactly a year beforehand.
During that period, 10y Treasury yields rose 117 basis points. However, once adjusted for negative carry and roll-down, an investor would have made only about 70bp, assuming a short position in 10y Treasuries was established on June 30, 2003 and held it for the next year.
Rainbows are always just over the horizon, the recovery is around the corner, and interest rate hikes are always two years away.
That timescale tends toward the far enough that we won’t start to discount it just yet, but close enough that we can claim to be anticipating it. (Who cares what happens in three years time, anyway?) Read more
So just how fast will the the Bank of England raise interest rates? For clues and pointers on its latest thinking now that employment has rapidly approached the thresholds (markers, thumb rules?) of forward guidance , the Inflation Report is out. Click to get straight to it:
Starting today we get what is basically the first formal step to a fully fledged market based deposit rate system from China (honourable mention of course to those more informal weapons of mass ponzi). It’s been coming and the move doesn’t effect corporates or individuals, but in the context of the Shibor spike, deposit pressure and the post-plenum reform blush it’s very worth noting.
From UBS’s Wang Tao:
[The PBOC] took the long-expected step toward liberalizing deposit rate on December 8, announcing that effective from December 9, depository financial institutions (banks) are allowed to issue large-denomination negotiable certificates of deposit, i.e., the so-called interbank CDs.
Word reaches us that the Credit Suisse axe will swing on Wednesday, with 50 heads to roll in the rates division as it bears the greatest brunt of cuts to fixed income, credit and commodities trading.
The Swiss bank has followed the lead of UBS in deciding that core fixed income trading is just too expensive, now that the whole flight to safety trade is over and lucrative over the counter business is dwindling. Read more
Something has been nagging at us this month — why were there so few market nerves apparent ahead of the possibility of a US government default, if the debt ceiling wasn’t lifted?
Not because we have any fresh insight into the chances of a political-cum-financial crisis in the US, but for what it says about a concept we think may describe much of the current situation in markets: sticky risk. Read more
They are billed as a quick and easy way for investors to gain access to higher-yielding assets while still providing some protection if interest rates start to rise. They are ETFs which track portfolios of (floating-rate) bank loans.
And they are on fire. Read more
The fixed income team at Credit Suisse have a good note talking about what’s really driving WTI backwardation. Small hint, they don’t think it’s much to do with Egypt.
They put the backwardation down to three things. Read more
The Reserve Bank of Australia’s deputy governor has been speaking on Thursday. Sadly there were no jokes but Philip Lowe did attempt to explain his boss’s side-splitting gag.
RTRS – RESERVE BANK OF AUSTRALIA DEPUTY GOV LOWE SAYS BOARD DID DELIBERATE FOR VERY LONG TIME, BUT ALWAYS DOES Read more
Lots of commentary is linking the mini-surge in WTI overnight, and subsequent WTI-Brent compression, to events in Egypt.
But it’s probably much more related to a shift in interest-rate expectations than anything to do with Middle Eastern tensions. Read more
That’s the new black according to Citi’s Steven Englander:
Since May 1 the median increase in 10-year local bond yields in 47 major EM and developed markets (DM) is 39bps (Figure 1). Among major EM economies (light blue) it is 83bps; among major DM (dark blue) economies it is 29bps. The US 10-year Treasury yield increase (red) is only at the median of developed economies and well below the overall median. In both EM and developed economies, the fat tail of rate increases is to the upside, so average increases are even higher. The paradox is that the run-up in US interest rates, which is arguably the primary driver of these global rate increases, is well below the average and median globally.
FT Alphaville was cordially invited to talk about the collateralisation of commodities at two separate conferences this past month. We thank IHS Global and the Association des Economiste Quebcois for the opportunity.
The crux of our argument was that you can’t really understand what’s going on in commodity markets unless you appreciate that commodities are no longer a pure consumption-based market. Read more
The disconnect we’ve noticed between commodity fundamentals and forward rates appears to be popping up in other asset classes as well.
Priya Misra, rates strategist at Bank of America Merrill Lynch, makes a very interesting point on Friday about what she sees in her sector. Read more
So Glenn Stevens likes the nags after all.
Well, sort of.
For the first time since he took the helm of the RBA in 2006, the governor did not tinker with interest rates on Melbourne Cup day (a public holiday across parts of the country). Read more